Wor­ries about Chi­nese stock mar­ket over­stated

The Chi­nese eq­uity mar­ket­may soon serve as a stan­dard case of what can go wrong in the fi­nan­cial sphere. But do we have to worry? Not much, at least not about China. The Chi­nese eq­uity mar­ket does not have much to do with the real econ­omy. It plays no ma­jor role in fi­nanc­ing Chi­nese in­vest­ment.

China’s eq­uity mar­ket is also not a lead­ing in­di­ca­tor for the coun­try’s busi­ness cy­cle. It fol­lows its own dy­nam­ics driven by liq­uid­ity, reg­u­la­tion and the usual pan­ics and ma­nias to which young fi­nan­cial mar­kets are even more prone than es­tab­lished ones.

The 150 per­cent surge by the Shang­hai Com­pos­ite In­dex from mid-2014 to its peak on June 12, 2015, did not lead to a ma­jor surge in busi­ness in­vest­ment and China’s GDP growth. And the fact that the mar­ket erased roughly some gains will not her­ald a ma­jor de­cline in Chi­nese in­vest­ment. How­ever, there will be some im­pact on corners of the pri­vate sec­tor— es­pe­cially on the con­sump­tion of lux­ury goods.

The im­por­tant point is that no mas­sive hit to ag­gre­gate GDP is in sight, be­yond per­haps a brief stum­ble. The coun­try’s lead­ers have all the means they need at their dis­posal to sup­port ag­gre­gate de­mand, if it threat­ens to fall far be­low the grad­u­ally mod­er­at­ing trend line.

China is try­ing to mod­ern­ize its over­all econ­omy and its fi­nan­cial sec­tor. The eq­uity boom’s bust does show that some of the fi­nan­cial lib­er­al­iza­tion has gone wrong. At the same time, it is worth re­call­ing that China is bet­ter able to con­tain the fall­out from fi­nan­cial prob­lems than any other ma­jor econ­omy in the world.

The coun­try has mas­sive for­eign ex­change re­serves, equal to about 35 per­cent of GDP; a do­mes­tic sav­ings rate of some 40 per­cent of dis­pos­able in­come; and a bal­anced ex­ter­nal sec­tor and bank­ing sys­tem that can re­spond fast to any cen­tral di­rec­tive to in­crease lend­ing, if ag­gre­gate de­mand needs a shot in the arm.

The real is­sue to watch out for is whether the tem­po­rary trou­ble in China’s fi­nan­cial sphere causes con­ta­gion to other emerg­ing mar­kets far away. If a ma­jor out­flow of money from many emerg­ing mar­kets (think Brazil) forces these coun­tries to raise rates and re­strict de­mand, this con­ta­gion could turn into a more sig­nif­i­cant prob­lem. That is true for Europe and the world econ­omy as a whole.

A se­ri­ous emerg­ing mar­ket cri­sis would be an ar­gu­ment for theUS Fed­eral re­serve not to raise rates in Septem­ber. At the mo­ment, this risk of con­ta­gion among emerg­ing mar­kets seems to be a more po­tent risk for the world econ­omy than the one of con­ta­gion from Greece. The au­thor is chief economist at Beren­berg Bank in Lon­don. The Glob­al­ist